Finally — a tax idea even worse than income-splitting

The federal government has delivered on the first of its two major tax promises from the 2011 election campaign. Income-splitting has been extensively assessed and widely criticized for its revenue cost, its tilt toward higher-income families, and its failure to accomplish anything beneficial for the economy.

Soon the other shoe may drop: The Conservative Party of Canada’s second major tax promise from the last election was to double the contribution limits for Tax-Free Savings Accounts. Surprisingly, this proposal has slipped under the radar not only of most tax policy analysts but also the media and the political opposition.

Yet doubling the TFSA limits would share the deficiencies of income-splitting as public policy — or even surpass them. It would drain revenues from both federal and provincial treasuries, with deceptively small initial sums adding up to costs far greater than those incurred through income-splitting. The long-run benefits would be far more sharply skewed toward the wealthy and high-earners. And doubling the TFSA limit would not benefit the economy in tangible ways.

Once the existing TFSA provision has fully matured in 40 to 50 years, it’s estimated to cost the federal treasury up to $15.5 billion annually — more than seven times the cost of income splitting. Provincial treasuries were insulated from the revenue impacts of income-splitting; they will not be so lucky with TFSAs, losing up to $9 billion per year when the scheme matures.

The government’s vow that TFSAs will never be considered in federal income tests for tax and benefit provisions carries further revenue costs. By mid-century, TFSAs will raise the Guaranteed Income Supplement’s cost by $2.8 billion annually and reduce recovery tax from Old Age Security by $1.2 billion annually. These figures are the official estimates; the sums projected by an independent analyst run far higher.

Thus, individuals with substantial TFSA balances will be able to draw benefits intended for low- and moderate-income seniors. Moreover, the mounting dollars lost to federal and provincial treasuries will increasingly flow into the pockets of high-earners. This skew of TFSA usage and benefits is already evident, and it will grow ever steeper as middle earners deplete their taxable assets available to shift into TFSAs.

All of these revenue losses and program costs would rise still further with the doubling of TFSA limits, although we lack an empirical basis to quantify the impacts. Nevertheless, my research finds that doubled TFSA limits would, in the long run, benefit few individuals other than the well-off along with some older workers and retirees.

Of individuals aged 60 years or less holding a TFSA in 2012, fewer than 16 per cent had used their full contribution limits — clear evidence that the current TFSA limit is more than adequate for the overwhelming majority. That figure would be even lower now, with another three years of access to the TFSA’s cumulative limits.

The current combined contribution limits for TFSAs and RRSPs together provide ample room — up to $30,000 per year — for the lifetime saving requirements of all workers earning up to at least $200,000 annually. TFSA-doubling would mean that an individual starting to save in their early twenties could accumulate between $1.4 million and $8 million over their lifetime — in addition to any workplace pensions and RRSPs.

Moreover, this doubly troubling outcome of adverse distributional tilt and major revenue losses would not pay returns in improved economic performance. The causal chain between household savings and domestic business investment suffers weak and broken links that undermine any positive gains for the economy from TFSA funds.

While unconditional TFSA-doubling fails the test of prudent fiscal policy, more constrained reforms could prove appropriate. Individuals could be allowed to convert unused RRSP contribution room into additional TFSA room. This approach avoids the pure windfall for the wealthy that would arise with unconditional TFSA-doubling.

Older workers and retirees could also be granted additional TFSA room to reflect the fact that they have fewer years to make contributions since the TFSA’s rollout in 2009. My research finds that of all age groups, persons over 60 years max out the current TFSA limits by far most frequently. This reform would make the scheme more equitable across cohorts.

At the same time, reforms to constrain the TFSA scheme would also appear desirable. The absolute immunity of TFSA holdings and income from the GIS and OAS clawbacks needs to be limited. Seniors with outsized TFSAs should not have unfettered access to public pension funds intended for those with little or limited incomes.

Some limits on the total accumulated balance in a TFSA might also be deemed appropriate. MoneySense magazine has a competition for the largest TFSA balance, and the current leaders are a couple who have accumulated TFSAs of more than $500,000 each, after the scheme has been operating only six years. Do we want to undercut the progressivity of our income tax system by allowing individuals to accumulate millions of dollars in their TFSAs entirely free of tax?

While the current TFSA scheme is not perfect, its deficiencies can be remedied through simple reforms. The system can be made more flexible for individuals who warrant it without opening the public vault to the highest earners and wealth holders.

The proposed doubling of TFSAs would fail to address the scheme’s existing shortcomings while simultaneously creating huge new ones. The great majority of Canadians would enjoy no significant long-run benefits from doubled TFSA limits. In fact, they would bear the burdens by enduring the constraint on public services or paying the increased taxes needed to offset the lost revenues.

Rhys Kesselman is Canada Research Chair in Public Finance with the School of Public Policy at Simon Fraser University and a Broadbent Institute Policy Fellow. His 2001 joint research laid the foundation for introduction of the TFSA in 2009. The Broadbent Institute has published his study evaluating the proposed doubling of TFSA contribution limits.